This section of the FEDERAL REGISTER

contains notices to the public of the proposed

issuance of rules and regulations. The

purpose of these notices is to give interested

persons an opportunity to participate in the

rule making prior to the adoption of the final

rules.

Proposed Rules Federal Register

54606 

Vol. 72, No. 186 

Wednesday, September 26, 2007 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–106143–07] 

RIN 1545–BG41 

Arbitrage Guidance for Tax-Exempt 

Bonds 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of Proposed Rulemaking 

and Notice of Public Hearing. 

SUMMARY: This document contains 

proposed regulations on the arbitrage 

restrictions under section 148 of the 

Internal Revenue Code applicable to taxexempt bonds issued by State and local 

governments. These proposed 

regulations are being issued in order to 

update existing regulations to address 

certain current market developments, to 

simplify and correct certain provisions, 

and to make existing regulations more 

administrable. These proposed 

regulations affect State and local 

governmental issuers of tax-exempt 

bonds. This document also provides 

notice of a public hearing on these 

proposed regulations. 

DATES: Written or electronic comments 

must be received by December 26, 2007. 

Outlines of topics to be discussed at the 

public hearing scheduled for January 30, 

2008, at 10 a.m., must be received by 

January 2, 2008. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–106143–07), 

Internal Revenue Service, PO Box 7604, 

Ben Franklin Station, Washington, DC 

20044. Submissions may be hand 

delivered to: CC:PA:LPD:PR Monday 

through Friday between the hours of 8 

a.m. and 4 p.m. to CC:PA:LPD:PR (REG– 

106143–07), Courier’s Desk, Internal 

Revenue Service, 1111 Constitution 

Avenue, NW., Washington, DC, or sent 

electronically via the Federal 

eRulemaking Portal at 

www.regulations.gov (IRS REG–106143– 

07). The public hearing will be held in 

the Main IRS Auditorium at the Internal 

Revenue Building, 1111 Constitution 

Avenue, NW., Washington, DC. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Carla Young, (202) 622–3980; 

concerning submissions of comments 

and the hearing, 

Richard.A.Hurst@irscounsel.treas.gov, 

or (202) 622–7180 (not toll-free 

numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

This document contains proposed 

amendments to the Income Tax 

Regulations (26 CFR part 1) on the 

arbitrage investment restrictions under 

section 148 of the Internal Revenue 

Code (Code). On June 18, 1993, the 

Treasury Department and the Internal 

Revenue Service (IRS) published 

comprehensive final regulations in the 

Federal Register (TD 8476, 58 FR 

33510) on the arbitrage investment 

restrictions and related provisions on 

tax-exempt bonds under sections 103, 

148, 149, and section 150 of the Code, 

and, since that time, those final 

regulations have been amended in 

certain limited respects (the regulations 

issued in 1993 and the amendments 

thereto are collectively referred to as the 

Existing Regulations). The Treasury 

Department and the IRS have since 

determined that certain provisions in 

the Existing Regulations need to be 

modified. This document contains 

proposed discrete amendments to the 

Existing Regulations (the Proposed 

Regulations) to update the Existing 

Regulations to address certain current 

market developments, to simplify 

certain provisions in the Existing 

Regulations, to correct certain technical 

issues in the Existing Regulations, and 

to make the Existing Regulations more 

administrable. 

In addition, the Treasury Department 

and the IRS are in the process of 

reviewing the Existing Regulations for 

future regulatory guidance on additional 

discrete issues for the same purposes. 

Explanation of Provisions 

I. Existing Regulations 

Section 103(a) of the Code generally 

excludes from gross income interest on 

a State or local bond. Under section 

103(b), however, the interest exclusion 

does not apply to an arbitrage bond, as 

defined in section 148. Section 148 

provides two related, but independent 

types of restrictions to determine 

whether a bond is an arbitrage bond: A 

yield restriction requirement and an 

arbitrage rebate requirement. Generally, 

these restrictions limit the ability of an 

issuer to invest bond proceeds in 

investments at a yield that materially 

exceeds the yield on the bond issue and 

require that certain excess earnings 

above the yield on the bond issue be 

rebated to the Federal government. 

Investment earnings that exceed the 

yield on the bond issue are commonly 

referred to as arbitrage. 

Under section 148(a) of the Code, the 

yield restriction requirement generally 

provides that a bond is an arbitrage 

bond if an issuer reasonably expects to 

earn arbitrage or if the issuer, 

subsequent to the issuance of the bonds, 

engages in a deliberate action to earn 

arbitrage on bond proceeds. Exceptions 

to the yield restriction requirement 

permit an issuer to earn arbitrage in 

limited circumstances, such as during 

limited temporary periods for prompt 

spending of bond proceeds and other 

similar temporary periods. 

Under section 148(f) of the Code, the 

arbitrage rebate requirement provides 

that a bond is an arbitrage bond if the 

issuer fails to timely rebate to the 

United States arbitrage otherwise 

permitted to be earned on certain 

investments acquired with bond 

proceeds. Generally, arbitrage rebate is 

paid every 5 years and upon the 

redemption of the bond issue. 

The Existing Regulations provide 

detailed rules for applying the two types 

of arbitrage restrictions, including rules 

for determining yield on the bond issue 

and yield on the investments, and rules 

for computing and paying arbitrage 

rebate. The Treasury Department and 

the IRS believe that discrete changes 

need to be made to the Existing 

Regulations to simplify and clarify 

certain provisions, to make certain 

provisions more administrable, and to 

update the regulations to reflect current 

market practices. 

II. Proposed Regulations 

The Proposed Regulations make a 

number of discrete changes to the 

Existing Regulations. Highlighted in this 

preamble are certain more substantive 

changes which are discussed in further 

detail. In addition, certain more minor 

changes are addressed in summary 

form. 


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(1) Hedges based on taxable interest 

rates. The Proposed Regulations make 

revisions to accommodate certain 

hedges in which floating payments 

under the hedge are based on a taxable 

interest rate and to clarify that bonds 

covered by such a hedge are ineligible 

for treatment as fixed yield bonds under 

the special hedging rule in § 1.148–

4(h)(4). 

(2) Joint Bond Yield Authority. The 

Proposed Regulations remove the 

provision in the Existing Regulations 

that permits the IRS Commissioner to 

authorize a single yield computation on 

multiple bond issues. 

(3) Electronic GIC Bidding. The 

Proposed Regulations revise the bidding 

safe harbor for establishing the fair 

market value of guaranteed investment 

contracts (GICs) to accommodate 

electronic bidding. 

(4) Refunds of Overpayments of 

Rebate. The Proposed Regulations 

clarify that the amount that an issuer is 

entitled to receive under a rebate refund 

claim is the excess of the total amount 

actually paid over the rebate amount. 

A. Changes To Accommodate Certain 

Hedges 

Section 1.148–4 of the Existing 

Regulations sets forth rules for 

determining the yield on an issue of 

bonds for purposes of applying the 

arbitrage rules. In general, § 1.148–4(h) 

of the Existing Regulations permits 

issuers to compute the yield on an issue 

by taking into account payments under 

‘‘qualified hedges.’’ The Existing 

Regulations provide two ways in which 

a qualified hedge can be taken into 

account in computing yield on the 

issue, known commonly as ‘‘simple 

integration’’ and ‘‘super integration.’’

For both simple integration and super 

integration, a hedge must be a ‘‘qualified 

hedge,’’ which is a hedge that meets a 

series of eligibility requirements. 

Generally, in order to be a qualified 

hedge, a hedge must be interest based, 

the terms of the hedge must correspond 

closely with the terms of the hedged 

bonds, the issuer must duly identify the 

hedge, and the hedge must contain no 

significant investment element. For 

super integration, the hedge must meet 

additional eligibility requirements 

which focus on assuring that the terms 

of the hedge and the hedge bonds 

sufficiently correspond so as to warrant 

treating the hedged bonds as fixed-yield 

bonds for arbitrage purposes. 

In the case of simple integration, 

generally all net payments on the hedge 

and the hedged bonds are taken into 

account in determining the yield on the 

bond issue. For example, if an issuer 

issues bonds paying interest at a 

variable rate and enters into a hedge 

under which the issuer receives floating 

interest rate payments from the hedge 

provider and pays fixed interest 

payments to the hedge provider (a 

variable-to-fixed hedge), the variable 

rate that the issuer pays to the 

bondholders, the floating rate that the 

issuer receives on the hedge, and the 

fixed payments that the issuer pays on 

the hedge are all taken into account on 

a net basis in determining the yield on 

the bond issue. In the case of simple 

integration, the hedged bonds are 

treated as variable yield bonds, which 

means that the yield on the bond issue 

is periodically recomputed and the 

rebate the issuer must pay to the United 

States is based on the issuer’s actual net 

payments and receipts on the bond and 

the hedge. Thus, for example, any ‘‘basis 

risk’’ difference between the actual 

interest rate that the issuer pays on its 

variable-yield hedged bond and the 

actual interest rate it receives on the 

floating interest rate on the hedge (along 

with the fixed payments on the hedge) 

is taken into account in determining the 

yield on the hedged bonds. 

In the case of super integration where 

the payments on the hedge and the 

hedged bonds sufficiently correspond so 

that the yield on the hedged bonds is 

fixed and determinable with certain 

assumptions, the hedged bonds are 

treated as fixed-yield bonds for arbitrage 

purposes. In the case of super 

integration, any basis risk difference 

between the floating-rate interest 

payments on the hedge and the variablerate interest payments on the hedged 

bonds is ignored in determining the 

yield on the hedged bonds for arbitrage 

purposes through an assumption that 

treats those floating and variable rates as 

the same. 

One of the eligibility requirements for 

a qualified hedge under the Existing 

Regulations is that it be interest based. 

For simple integration, one of the 

subsidiary aspects used in determining 

whether a variable-to-fixed interest rate 

hedge is interest based focuses on 

whether the variable interest rate on the 

hedged bonds and the floating interest 

rate on the hedge are ‘‘substantially the 

same.’’ For super integration purposes, 

such rates must be ‘‘reasonably expected 

to be substantially the same throughout 

the term of the hedge.’’ This aspect of 

the interest-based contract standard has 

raised technical issues in recent years in 

connection with its application to 

certain kinds of hedges, as discussed 

further in this preamble. 

In general, hedging plays an 

increasingly important role in the taxexempt bond market. An issuer of bonds 

may use hedges to protect itself against 

interest rate risks. For example, an 

issuer that issues variable-rate bonds 

may hedge or protect itself against 

unfavorable interest rate changes in the 

market by entering into a variable-tofixed interest rate swap. Historically, 

issuers of tax-exempt bonds generally 

used a type of swap under which the 

hedge provider paid a floating interest 

rate that was determined based on a 

market index of tax-exempt interest 

rates, such as the Securities Industry 

and Financial Markets Association 

(SIFMA) Municipal Swap Index. 

A significant development in the taxexempt bond market since the 

promulgation of the Existing 

Regulations has been the trend toward 

the use by issuers of variable-to-fixed 

interest rate swaps as hedges in which 

the floating interest rate that the swap 

provider pays to the issuer is 

determined based on a percentage of a 

market index of taxable interest rates, 

such as the London Interbank Offered 

Rate (LIBOR) (a taxable-index hedge). 

Issuers have indicated that these 

taxable-index hedges offer more 

liquidity, more transparency in pricing, 

and lower costs than hedges based on a 

tax-exempt interest index. 

Issuers have raised interpretative 

questions about how to apply the 

qualified hedge provisions of the 

Existing Regulations to taxable-index 

hedges because interest rates on taxable 

indices generally do not correspond as 

closely as interest rates on tax-exempt 

market indices to actual market interest 

rates on tax-exempt, variable-rate bonds. 

These interpretative questions are 

particularly important for taxable-index 

hedges used with advance refunding 

bond issues because issuers generally 

need to use the qualified hedge rules or 

some other regime to determine with 

certainty the yield on the tax-exempt 

advance refunding bonds in order to 

comply with the applicable arbitrage 

yield restrictions on investments in 

defeasance escrows. 

The IRS and the Treasury Department 

have determined that taxable-index 

hedges based on widely-used taxable 

indices, such as LIBOR based hedges, 

sufficiently improve the efficiency of 

the tax-exempt bond market to warrant 

accommodation. The Proposed 

Regulations accommodate these hedges 

by modifying (1) the provisions for 

‘‘yield reduction payments,’’ which 

permit an issuer to reduce yield on an 

investment by making payments to the 

Federal government in certain permitted 

circumstances to comply with yield 

restriction rules and (2) the qualified 

hedge provisions. The Proposed 

Regulations make clear, however, that 

while taxable-index hedges can be 


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qualified hedges, and therefore eligible 

for simple integration, they are not 

eligible for super integration because 

there is an insufficient correlation 

between tax-exempt bond interest rates 

and taxable market interest rate indices. 

However, the IRS and the Treasury 

Department understand that issuers 

have recently issued variable-rate bonds 

that bear interest equal to a percentage 

of LIBOR, and seek public comments on 

whether special accommodation under 

the super integration rule is required for 

those bond issues. 

Yield reduction payments effectively 

integrate the yield restriction 

requirements with the arbitrage rebate 

requirements. For certain limited 

situations, § 1.148–5(c) of the Existing 

Regulations permits yield reduction 

payments to be paid to the United States 

to satisfy yield restriction requirements 

on certain investments. Yield reduction 

payments are similar to, but not 

identical to, rebate payments. In general, 

the purpose of the yield reduction 

payment rules is to simplify compliance 

with the sometimes overlapping yield 

restriction and arbitrage rebate 

requirements by allowing issuers to 

make payments similar to rebate 

payments to the United States to satisfy 

yield restriction and rebate in 

appropriate circumstances. For 

example, an issuer may effectively 

reduce the yield on an investment to a 

yield that will not violate the yield 

restriction rules and also satisfy the 

arbitrage rebate requirement through a 

yield reduction payment. 

The Proposed Regulations modify the 

yield reduction payment rules to permit 

issuers to make yield reduction 

payments on certain variable-yield 

advance refunding issues in which the 

issuer has entered into a qualified hedge 

in the form of a variable-to-fixed interest 

rate swap to hedge its interest rate risk. 

This modification to the yield reduction 

rule applies for nonpurpose investments 

allocable to gross proceeds of an 

advance refunding issue deposited into 

an advance refunding escrow when: (1) 

The issuer has entered into a qualified 

hedge in the form of a variable-to-fixed 

interest rate swap on all of its variablerate bonds that are allocable to the yield 

restricted defeasance escrow, (2) the 

hedge covers a period from the issue 

date of the bonds until the final 

payment is made from the defeasance 

escrow, and (3) the yield on the advance 

refunding escrow is not reasonably 

expected to exceed the yield on the 

issue, determined by taking into account 

the fixed payments that the issuer is 

expected to make under the hedge and 

by assuming that the corresponding 

variable interest payments to be made 

by the issuer on the hedged bonds and 

to be received by the issuer on the hedge 

are equal and paid on the same date. In 

effect, the Proposed Regulations allow 

yield reduction payments in this context 

only to be made to cover the basis risk 

differences between the hedge and the 

hedged bonds. 

The Proposed Regulations also modify 

the qualified hedge provisions to 

provide that the floating rate on the 

taxable-index hedge and the variable 

rate on the hedged bonds will be treated 

as substantially the same for purposes of 

§ 1.148–4(h)(2)(v)(B) if: (1) The 

difference between the two rates is not 

greater than one-quarter of one percent 

(.25 percent, or 25 basis points) on the 

date the issuer enters into the hedge, 

and (2) for a three-year period that ends 

on the date the issuer enters into the 

hedge, the average difference between 

the issuer’s actual tax-exempt interest 

rate on comparable variable-rate bonds 

(or, if no such comparable bonds exist, 

a reasonable tax-exempt interest rate 

index, such as the SIFMA Municipal 

Swap Index, for that same period) and 

an interest rate determined in the same 

manner as the floating interest rate on 

the hedge does not exceed one-quarter 

of one percent (.25 percent, or 25 basis 

points). For example, if the floating rate 

on the hedge is 67 percent of LIBOR, 

then 67 percent of LIBOR, determined 

on the same days as the issuer’s actual 

interest rates (or tax-exempt index, if 

applicable) are determined, is compared 

to the issuer’s actual interest rates (or 

the tax-exempt index, if applicable) for 

the three-year period ending on the date 

the hedge is entered into and the 

differences are averaged to determine 

whether the average difference exceeds 

one-quarter of one percent. For this 

purpose, a reasonable sample may be 

used if the sample for the issuer’s actual 

rates (or tax-exempt market index rates, 

if applicable) and the sample of floating 

rates used for the hedge are determined 

as of the same dates. 

The Proposed Regulations also make 

certain other limited changes to the 

hedging and yield reduction rules 

which are discussed with other 

miscellaneous changes in this preamble. 

B. Joint Yield Authority 

In general, for arbitrage purposes, the 

yield on a bond issue is determined on 

an issue-by-issue basis. Section 1.148–

4(a) of the Existing Regulations, 

however, authorizes the IRS 

Commissioner to permit issuers of 

certain types of tax-exempt bonds, 

specifically qualified mortgage bonds 

and qualified student loan bonds, to 

compute a single joint bond yield for 

purposes of applying the arbitrage 

restrictions to two or more issues of 

these types of tax-exempt bonds. 

Since the promulgation of the Existing 

Regulations, the IRS has received 

numerous private letter ruling requests 

for joint bond yield computations and 

has ruled on one of these requests. The 

Treasury Department and the IRS, based 

on what the IRS has learned from these 

ruling requests, are concerned about the 

highly factual nature of the requests, 

and the potential for arbitrage 

manipulations with joint yield 

computations that would not be 

apparent from a private letter ruling 

request and that could not reasonably be 

discovered in the context of such a 

request. For these reasons, the Proposed 

Regulations eliminate the regulatory 

provision that permits joint yield 

computations. However, the Treasury 

Department and the IRS are considering 

whether generally applicable, objective 

standards can be created under which 

joint yield computations should be 

allowed. Accordingly, the Proposed 

Regulations solicit public comments on 

when joint yield computations are 

needed for sound business reasons and 

whether objective standards can be 

created that would allow these 

computations in a manner that is 

consistent with the purposes of section 

148. In addition, comments are sought 

on the following: The treatment of openended joint yield calculations that allow 

future issues to be included in the joint 

yield computation, the treatment of 

qualified hedges or guarantees that 

cover some but not all of the bonds, the 

treatment of reserves, the application of 

prepayment assumptions, the effect of 

partial refundings, and other issues that 

impact the administrability of joint 

yield calculations. Pending final 

resolution of this issue, the IRS will not 

entertain any private letter ruling 

requests for permission to use a joint 

yield computation. 

C. Modified Fair Market Value Safe 

Harbor for Guaranteed Investment 

Contracts 

Under § 1.148–5(d)(3) of the Existing 

Regulations, investments purchased 

with bond proceeds must be valued at 

fair market value. Section 1.148–

5(d)(6)(iii) of the Existing Regulations 

provides a safe harbor for establishing 

the fair market value of a guaranteed 

investment contract (GIC) for arbitrage 

purposes. That safe harbor generally 

relies on a prescribed bidding procedure 

and the receipt of at least three bids 

from independent parties. The bidding 

process requirements under the safe 

harbor include a requirement that all 

bidders be given an equal opportunity to 

bid with no opportunity to review other 


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bids (that is, the ‘‘no last look’’ rule) and 

a requirement that the bid specifications 

be provided to prospective bidders ‘‘in 

writing.’’

In the past several years, the taxexempt bond market has seen the 

advent of various electronic bidding 

procedures and internet platforms for 

bidding GICs. While the particular 

features of specific GIC bidding 

procedures may vary, characteristics of 

these electronic GIC bidding procedures 

generally include using the internet to 

receive bid specifications and to make 

bids. The electronic bidding process 

permits providers, under prescribed 

times and procedures, to continuously 

bid and to continuously view the 

current highest bids (without 

identification of the bidders). The 

electronic platforms also provide the 

capability to print out the results of the 

GIC bidding process. The electronic GIC 

bidding procedures have raised certain 

technical issues regarding whether they 

can comply with the fair market value 

safe harbor for GICs under the Existing 

Regulations. 

The Treasury Department and the IRS 

believe that electronic GIC bidding 

procedures generally offer the 

constructive potential for increasing the 

transparency of pricing of investments 

purchased with proceeds of tax-exempt 

bonds. Accordingly, the Proposed 

Regulations amend the fair market value 

safe harbor for GICs to accommodate 

electronic bidding procedures by (1) 

permitting bid specifications to be sent 

electronically over the Internet or by fax 

and (2) amending the no last look rule 

to provide that there is not a prohibited 

last look if all bidders have an equal 

opportunity for a last look. 

D. Recovery of Overpayment of Rebate 

Generally, an issuer computes the 

amount of arbitrage rebate that it owes 

under a method that future values 

payments and receipts on investments 

using the yield on the bond issue. Under 

this method, an arbitrage payment made 

on one computation date is future 

valued to the next computation date to 

determine the amount of arbitrage rebate 

owed on that subsequent computation 

date. Section 1.148–3(i)(1) of the 

Existing Regulations provides that an 

issuer may recover an overpayment of 

arbitrage rebate with respect to an issue 

of tax-exempt bonds if the issuer 

establishes to the satisfaction of the IRS 

Commissioner that an overpayment 

occurred. Section 1.148–3(i)(1) further 

defines an overpayment as the excess of 

‘‘the amount paid’’ (emphasis added) to 

the United States for an issue under 

section 148 over the sum of the rebate 

amount for that issue as of the most 

recent computation date and all 

amounts that are otherwise required to 

be paid under section 148 as of the date 

the recovery is requested. Thus, even if 

the future value of the issuer’s arbitrage 

rebate payment on a computation date, 

computed under the method for 

determining arbitrage rebate, is greater 

than the issuer’s rebate amount on that 

date, an issuer is only entitled to a 

refund to the extent that the amount 

actually paid exceeds that rebate 

amount. The Existing Regulations limit 

the amount of the refund in this manner 

because the Treasury Department and 

the IRS were concerned about whether 

the IRS had statutory authority to pay 

interest on arbitrage rebate payments. 

To permit a refund in an amount 

calculated in whole or in part based 

upon a future value of the amount 

actually paid would effectively result in 

an interest payment on that payment. 

Example 2(iii)(D) in § 1.148–3(j) of the 

Existing Regulations has caused 

confusion because it could be 

interpreted to mean that an issuer can 

receive a refund of a rebate payment 

when the future value of such rebate 

payment exceeds the rebate amount on 

the next computation date, even though 

the actual amount of the previous rebate 

payment does not exceed the rebate 

amount on that next computation date. 

The Proposed Regulations make a 

technical amendment to this example to 

conform this example to the intended 

purpose of § 1.148–3(i)(1). Because the 

proposed change does not change the 

regulatory rule, but merely makes an 

existing example conform to that rule, 

the Proposed Regulations provide that 

the effective date for this provision is 

the same as the effective date for the 

regulatory rule. However, the IRS will 

not reopen rebate refund claims that 

have been processed before the date the 

Proposed Regulations are published in 

the Federal Register. 

E. Other Miscellaneous Changes 

1. Qualified Hedge Provisions 

The Proposed Regulations make the 

following additional changes to the 

hedging rules in § 1.148–4(h) and 

specifically seek the following 

comments on the hedging rules. 

a. Cost of Funds Hedges. The 

Proposed Regulations clarify that for 

purposes of applying the definition of 

periodic payment under § 1.446–3(e)(1) 

to determine whether a hedge has a 

significant investment element under 

§ 1.148–4(h)(2)(ii)(A), a ‘‘specified 

index’’ under § 1.446–3(c)(2) (upon 

which periodic payments are based) is 

deemed to include payments under a 

cost-of-funds swap, thereby eliminating 

any doubt that these hedges can be 

qualified hedges. 

b. Size and Scope of a Qualified 

Hedge. The Proposed Regulations add 

an express requirement under § 1.148–

4(h)(2)(v) that limits the size and scope 

of a qualified hedge to a level that is 

reasonably necessary to hedge the 

issuer’s risk with respect to interest rate 

changes on the hedged bonds. This 

proposed limitation is comparable to a 

former provision that was in the 

arbitrage regulations from 1993 to 1997, 

but was removed in connection with 

1997 amendments to the Existing 

Regulations. The Treasury Department 

and the IRS believe that this principle 

was implicitly carried forward in the 

subsidiary standards under the interestbased contract requirement in the 

Existing Regulations in 1997. The 

Proposed Regulations, however, provide 

an explicit separate requirement to 

clarify the continued application of this 

principle. 

c. Correspondence of Payments for 

Simple Integration. Commentators have 

requested guidance on what time period 

satisfies the rule under § 1.148–

4(h)(2)(vi) that requires payments on a 

hedge to correspond closely in time to 

the payments on the hedged bonds. The 

Proposed Regulations add a rule for 

simple integration that treats payments 

as corresponding closely in time for this 

purpose if the payments are made 

within 60 calendar days of each other. 

This proposed rule contrasts with the 

rules for super integration, which 

require that payments be made within 

15 days of each other. The Proposed 

Regulations provide a more flexible time 

period for correspondence of payments 

for simple integration purposes 

consistent with the fact that simple 

integration results in more accurate 

accounting for all net payments. 

d. Time for Identification of Qualified 

Hedges. Commentators have indicated 

that the three-day period for identifying 

a hedge under § 1.148–4(h)(2)(viii) of 

the Existing Regulations raises practical 

difficulties, particularly with respect to 

hedges that are not entered into 

contemporaneously with the issuance of 

the hedged bonds. The Proposed 

Regulations extend the time in § 1.148–

4(h)(2)(viii) for when an issuer must 

identify a qualified hedge from three 

days to fifteen days and clarify that 

these are calendar days. The Proposed 

Regulations, however, retain the 

requirement that the actual State or 

local governmental issuer, rather than 

the conduit borrower, identify the hedge 

because the Treasury Department and 

the IRS believe that it is important for 

State and local governments to be 


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responsible for qualified hedges on their 

bonds. 

e. Termination of Hedges at Fair 

Market Value. The Proposed 

Regulations clarify that under § 1.148–

4(h)(3)(iv)(B), the termination payment 

for a termination or a deemed 

termination is equal to the fair market 

value of the hedge on the termination 

date. 

f. Solicitation of Comment on 

Offsetting Hedges. The Treasury 

Department and the IRS have received 

requests for clarification of the scope of 

the rule that treats offsetting hedges as 

deemed terminations of qualified 

hedges under § 1.148–4(h)(3)(iv)(A). The 

Treasury Department and the IRS seek 

express public comment regarding the 

types of offsetting hedges that are 

necessary for valid business purposes 

and recommendations on how to clarify 

the scope of this rule on offsetting 

hedges. 

2. Yield Reduction Payment Rules 

The Proposed Regulations permit 

issuers to make yield reduction 

payments for nonpurpose investments 

allocable to proceeds of an issue, 

including an advance refunding issue, 

that an issuer purchases on a date when 

the issuer is unable to purchase State 

and Local Government Series Securities 

(SLGS) because the Department of 

Treasury, Bureau of Public Debt, has 

suspended sales of SLGS. This 

provision incorporates and expands 

Revenue Procedure 95–47, 1995–2 CB 

417, which permits yield reduction 

payments in more limited situations 

than the Proposed Regulations when 

SLGS are unavailable. 

The Proposed Regulations also 

reorganize the yield reduction rules to 

make them easier to read. 

3. Modification of Yield Computation 

for Yield-to-Call Premium Bonds 

The Proposed Regulations simplify 

the rules for computing yield on an 

issue that has certain callable premium 

bonds. Existing Regulations generally 

provide that the yield on an issue is 

based on the yield to maturity, taking 

into account certain assumptions. The 

Existing Regulations have a special rule 

for certain callable bonds issued with 

significant amounts of bond premium 

(sometimes called yield-to-call bonds), 

which requires a determination of yield 

to a call date, based on certain assumed 

optional redemptions. The general 

purpose of this rule is to recognize that 

a yield-to-maturity computation may 

not be economically accurate in this 

circumstance because these yield-to-call 

bonds are more likely than other bonds 

to be called before maturity and before 

amortization of the premium. 

Section 1.148–4(b)(3)(i) of the Existing 

Regulations treats a yield-to-call bond as 

redeemed at the stated redemption price 

on the optional redemption date that 

would produce the lowest yield on the 

issue (as contrasted with the lowest 

yield on the particular premium bond). 

This methodology, which considers the 

lowest yield on the issue for these yieldto-call bonds, requires computations of 

possible combinations of redemption 

dates in circumstances in which the 

variations of redemption dates may have 

very limited impact on yield. 

The Proposed Regulations simplify 

the yield calculations for these yield-tocall bonds to focus on the redemption 

date that results in the lowest yield on 

the particular premium bond (rather 

than the more complex existing focus on 

the lowest yield on the issue). This 

change corresponds to a former version 

of this regulatory rule which was in 

effect under applicable arbitrage 

regulations from 1989 through 1992. 

4. Arbitrage Rebate Computation Credit 

Section 1.148–3(d)(1)(iv) of the 

Existing Regulations provides that an 

issuer may take certain credits against 

payment of arbitrage rebate in the 

amount of $1,000 for each rebate 

computation date, subject to certain 

limitations, to help offset the cost of 

computing rebate. The Proposed 

Regulations increase this rebate credit to 

$1,400 for any bond year ending in the 

year 2007 to reflect the change in the 

Consumer Price Index since the $1,000 

rebate credit was published. The 

Proposed Regulations further adjust the 

computation date credit for inflation for 

bond years ending in each year 

thereafter. 

5. External Commingled Investment 

Funds 

The Existing Regulations provide 

certain preferential rules for the 

treatment of administrative costs to 

certain widely-held ‘‘external 

commingled funds,’’ as defined in 

§ 1.148–5(e)(2)(ii)(B). Under the Existing 

Regulations, a fund is treated as widely 

held if the fund, on average, has more 

than 15 unrelated investors, each of 

which maintains prescribed minimum 

average investments in the fund. The 

Proposed Regulations make a technical 

change to allow additional smaller 

investors to invest in an external 

commingled fund without disqualifying 

the fund so long as at least 16 unrelated 

investors each maintain the required 

minimum average investments in the 

fund. 

6. Pooled Bonds 

The Proposed Regulations make 

conforming changes to § 1.148–8(d) to 

reflect legislative changes made to 

section 148(f)(4)(D) by section 508 of the 

Tax Increase Prevention and 

Reconciliation Act of 2005, Pub. L. No. 

109–222, 120 Stat. 345 (TIPRA). Under 

TIPRA, Congress eliminated the rule in 

§ 148(f)(4)(D)(ii)(II) that permitted a pool 

bond issuer to ignore its pool bond issue 

in computing whether it had exceeded 

its $5 million limit for purposes of the 

small issuer rebate exception of section 

148(f)(4)(D). Correspondingly, the 

Proposed Regulations eliminate the 

provisions in the Existing Regulations 

that permit a pool bond issuer to ignore 

the amount of its pool bond issue in 

determining whether the issuer meets 

the small issuer exception of section 

148(f)(4)(D). The Proposed Regulations 

retain the provision that permits a State 

or local governmental conduit borrower 

to ignore the amount of certain pool 

bond issues in excess of the amount it 

borrows from that pool. Consistent with 

the statutory change, the Proposed 

Regulations provide that the change for 

pool bond issuers is effective for bonds 

issued after May 17, 2006, the effective 

date of the relevant provision of TIPRA. 

III. Effective Dates 

The Proposed Regulations are 

proposed to apply to bonds sold on or 

after a date that is 90 days after 

publication of final regulations in the 

Federal Register, but an issuer may 

apply certain specified provisions of the 

Proposed Regulations to bonds sold 

before the date that is 90 days after 

publication of the final regulations in 

the Federal Register as provided in 

proposed § 1.148–11(k). Except for the 

changes to the qualified hedging rules 

which must be applied in their entirety, 

issuers that are permitted, but not 

required, to apply the proposed changes 

may apply some or all of the changes to 

a bond issue. 

The Proposed Regulations contain a 

technical amendment to the example in 

the general arbitrage rebate rules. This 

change applies to bonds subject to 

§ 1.148–3(i), the dates of applicability 

for which are set forth in the Existing 

Regulations. 

The Proposed Regulations contain a 

special effective date provision for the 

regulatory change that conforms the 

arbitrage regulations to the legislative 

change made to the small issuer rebate 

exception for pooled bond issuers. This 

change applies to bonds issued after 

May 17, 2006, the effective date of the 

relevant provision of TIPRA. 


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Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 / Proposed Rules 54611 

Effect on Other Documents 

On the date of applicability of the 

final regulations, Revenue Procedure 

95–47, 1995–2 CB 417, will be 

obsoleted. 

Special Analyses 

It has been determined that this notice 

of proposed rulemaking is not a 

significant regulatory action as defined 

in EO 12866. Therefore, a regulatory 

assessment is not required. It is hereby 

certified that these proposed regulations 

will not have a significant economic 

impact on a substantial number of small 

entities. Therefore, a Regulatory 

Flexibility Analysis under the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) is not required. Some of the 

proposed changes clarify existing 

regulatory provisions, conform the 

regulations to a recent statutory change, 

or otherwise involve simplifying or 

clarifying changes that will not have a 

significant economic impact on 

governmental jurisdictions or other 

entities of any size. Other proposed 

changes involve the treatment of certain 

hedging transactions, such as interest 

rate swaps, for purposes of the arbitrage 

investment restrictions on tax-exempt 

bonds issued by State and local 

governments. Although there is a lack of 

available data regarding the extent of 

usage of these hedging transactions by 

small entities, the IRS and the Treasury 

Department understand that these 

hedging transactions are used primarily 

by larger State and local governments 

and other eligible larger entities. The 

IRS and the Treasury Department 

specifically solicit comment from any 

party, particularly affected small 

entities, on the accuracy of this 

certification. Pursuant to section 7805(f) 

of the Internal Revenue Code, this 

regulation has been submitted to the 

Small Business Administration for 

comment on its impact on small 

governmental jurisdictions. 

Comments and Public Hearing 

Before these Proposed Regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. The 

Treasury Department and IRS request 

comments on the clarity of the proposed 

rules and how they can be made easier 

to understand. All comments will be 

available for public inspection and 

copying. 

A public hearing has been scheduled 

for January 30, 2008 at 10 a.m. in the 

Main IRS Auditorium, Internal Revenue 

Service Building, 1111 Constitution 

Avenue, NW., Washington, DC. Due to 

building security procedures, visitors 

must enter at the Constitution Avenue 

entrance. In addition, all visitors must 

present photo identification to enter the 

building. Because of access restrictions, 

visitors will not be admitted beyond the 

immediate entrance area more than 30 

minutes before the hearing starts. For 

information about having your name 

placed on the building access list to 

attend the hearing, see the FOR FURTHER

INFORMATION CONTACT section of this 

preamble. 

The rules of 26 CFR 601.601(a)(3) 

apply to the hearing. Persons who wish 

to present oral comments at the hearing 

must submit written or electronic 

comments and an outline of the topics 

to be discussed and the time to be 

devoted to each topic (a signed original 

and eight (8) copies) by January 2, 2008. 

A period of 10 minutes will be allotted 

to each person for making comments. 

An agenda showing the scheduling of 

the speakers will be prepared after the 

deadline for receiving outlines has 

passed. Copies of the agenda will be 

available free of charge at the hearing. 

Drafting Information 

The principal authors of these 

regulations are Rebecca L. Harrigal and 

Carla A. Young, Office of Associate 

Chief Counsel (Financial Institutions 

and Products), IRS. However, other 

personnel from the IRS and Treasury 

Department participated in their 

development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

Sections 1.148–0, 1.148–3, 1.148–4, 1.148–

5, 1.148–8 and 1.148–11 also issued under 26 

U.S.C. 148(i). 

Par. 2. Section 1.148–0(c) is amended 

as follows: 

1. Add entry for new paragraph (d)(4) 

in the table of contents for § 1.148–3. 

2. Revise entry for paragraph (d) in 

the table of contents for § 1.148–8. 

3. Remove entries for paragraph (d)(1) 

and paragraph (d)(2) in the table of 

contents for § 1.148–8. 

4. Add entries for new paragraphs (k), 

(k)(1), (k)(2), (k)(3) and (k)(4) in the table 

of contents for § 1.148–11. 

The revised and added provisions 

read as follows: 

§ 1.148–0 Scope and Table of Contents. 

* * * * * 

§ 1.148–3 General arbitrage rebate rules. 

* * * * * 

(d) * * * 

(4) Cost-of living adjustment. 

* * * * * 

§ 1.148–8 Small issuer exception to rebate 

requirement. 

* * * * * 

(d) Pooled financings—treatment of 

conduit borrowers. 

* * * * * 

§ 1.148–11 Effective dates. 

* * * * * 

(k) Certain arbitrage guidance updates. 

(1) In general. 

(2) Permissive earlier application. 

(3) Rebate overpayment recovery. 

(4) Small issuer exception to rebate 

requirement for conduit borrowers of pooled 

financings. 

* * * * * 

Par. 3. Section 1.148–3 is amended by 

revising paragraph (d)(1)(iv) and adding 

a new paragraph (d)(4) as follows: 

§ 1.148–3 General arbitrage rebate rules. 

* * * * * 

(d) * * * 

(1) * * * 

(iv) On the last day of each bond year 

during which there are amounts 

allocated to gross proceeds of an issue 

that are subject to the rebate 

requirement, and on the final maturity 

date, a computation credit of $1,400 for 

any bond year ending in 2007 and, for 

bond years ending after 2007, a 

computation credit in the amount 

determined under paragraph (d)(4) of 

this section; and 

* * * * * 

(4) Cost-of-living adjustment. For any 

calendar year after 2007, the $1,400 

computation credit set forth in 

paragraph (d)(1)(iv) shall be increased 

by an amount equal to such dollar 

amount multiplied by the cost-of-living 

adjustment determined under section 

1(f)(3) for such year as modified by this 

paragraph (d)(4). In applying section 

1(f)(3) to determine this cost-of-living 

adjustment, the reference to ‘‘calendar 

year 1992’’ in section 1(f)(3)(B) shall be 

changed to ‘‘calendar year 2006.’’ If any 

such increase determined under this 

paragraph (d)(4) is not a multiple of $10, 

such increase shall be rounded to the 

nearest multiple thereof. 

* * * * * 


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Par. 4. Section 1.148–3(j) is amended 

by revising Example 2(iii)(D) to read as 

follows: 

§ 1.148–3 General arbitrage rebate rules. 

* * * * * 

(j) * * * 

Example 2. * * * 

(iii) * * * 

(D) If the yield during the second 

computation period were, instead, 

7.0000 percent, the rebate amount 

computed as of July 1, 2004, would be 

$1,320,891. The future value of the 

payment made on July 1, 1999, would 

be $1,471,007. Although the future 

value of the payment made on July 1, 

1999 ($1,471,007), exceeds the rebate 

amount computed as of July 1, 2004 

($1,320,891), § 1.148–3(i) limits the 

amount recoverable as a defined 

overpayment of rebate under section 

148 to the excess of the total ‘‘amount 

paid’’ over the sum of the amount 

determined under the future value 

method to be the ‘‘rebate amount’’ as of 

the most recent computation date and 

all other amounts that are otherwise 

required to be paid under section 148 as 

of the date the recovery is requested. 

Because the total amount that the issuer 

paid on July 1, 1999 ($1,042,824.60), 

does not exceed the rebate amount as of 

July 1, 2004 ($1,320,891), the issuer 

would not be entitled to recover any 

overpayment of rebate in this case. 

* * * * * 

Par. 5. Section 1.148–4(a) is revised to 

read as follows: 

§ 1.148–4 Yield on an issue of bonds. 

(a) In general. The yield on an issue 

of bonds is used to apply investment 

yield restrictions under section 148(a) 

and to compute rebate liability under 

section 148(f). Yield is computed under 

the economic accrual method using any 

consistently applied compounding 

interval of not more than one year. A 

short first compounding interval and a 

short last compounding interval may be 

used. Yield is expressed as an annual 

percentage rate that is calculated to at 

least four decimal places (for example, 

5.2525 percent). Other reasonable, 

standard financial conventions, such as 

the 30 days per month/360 days per 

year convention, may be used in 

computing yield but must be 

consistently applied. The yield on an 

issue that would be a purpose 

investment (absent section 148(b)(3)(A)) 

is equal to the yield on the conduit 

financing issue that financed that 

purpose investment. 

* * * * * 

Par. 6. Section 1.148–4 is amended 

by: 

1. Revising paragraph (b)(3)(i), and 

adding a new sentence at the end of 

paragraph (h)(2)(ii)(A). 

2. Revising the heading and 

introductory text of paragraph (h)(2)(v). 

3. Amending paragraph (h)(2)(v)(B) by 

revising the last sentence. 

4. Adding paragraphs (h)(2)(v)(B)(1), 

(2) and (3). 

5. Adding a new sentence at the end 

of paragraph (h)(2)(vi). 

6. Revising the heading and first 

sentence of paragraph (h)(2)(viii). 

7. Amending paragraph (h)(3)(iv)(B) 

by adding a new sentence immediately 

after the first sentence. 

8. Adding a new sentence at the end 

of paragraph (h)(4)(i)(C). 

The revised and added provisions 

read as follows: 

§ 1.148–4 Yield on an issue of bonds. 

* * * * * 

(b) * * * 

(3) Yield on certain fixed yield bonds 

subject to optional early redemption—(i) 

In general. If a fixed yield bond is 

subject to optional early redemption and 

is described in paragraph (b)(3)(ii) of 

this section, the yield on the issue 

containing the bond is computed by 

treating the bond as redeemed at its 

stated redemption price on the optional 

redemption date that would produce the 

lowest yield on that bond. 

* * * * * 

(h) * * * 

(2) * * * 

(ii) * * * 

(A) * * * For purposes of applying 

the definition of periodic payment 

under § 1.446–3 to determine whether a 

hedge has a significant investment 

element under this paragraph 

(h)(2)(ii)(A), the definition of ‘‘specified 

index’’ under § 1.446–3 (upon which 

periodic payments are required to be 

based) is deemed also to include 

payments an issuer receives under a 

hedge that are computed to be equal to 

the issuer’s cost of funds, such as the 

issuer’s actual market-based tax-exempt 

variable interest rate on its bonds. 

* * * * * 

(v) Interest-based contract and size 

and scope of hedge. The contract is 

primarily interest-based (for example, a 

hedge based on a debt index rather than 

an equity index). In addition, the size 

and scope of the hedge under the 

contract is limited to that which is 

reasonably necessary to hedge the 

issuer’s risk with respect to interest rate 

changes on the hedged bonds. For 

example, a contract is limited to 

hedging an issuer’s risk with respect to 

interest rate changes on the hedged 

bonds if the hedge is based on the 

issuer’s principal amount of bonds and 

reasonably expected interest 

requirements rather than based on a 

greater notional amount or an interest 

rate level greater than the expected 

interest requirements. A contract is not 

primarily interest based unless—

* * * * * 

(B) * * * For this purpose, 

differences that would not prevent the 

resulting bond from being substantially 

similar to another type of bond or to 

result in overhedging include: (1) A difference between the interest 

rate used to compute payments on the 

hedged bond and the interest rate used 

to compute payments on the hedge 

where one interest rate is substantially 

the same as, but not identical to, the 

other. For this purpose, if an interest 

rate swap under which the issuer pays 

the hedge provider a fixed interest 

payment and receives from the hedge 

provider a floating interest rate that is 

based on a taxable interest rate or a 

taxable market interest rate index, the 

floating rate on the hedge and the 

variable rate on the hedged bonds will 

be treated as being substantially the 

same only if: (i) The difference between the interest 

rate on the issuer’s hedged bonds and 

the floating interest rate on the hedge 

does not exceed one quarter of one 

percent (.25 percent, or 25 basis points) 

on the date that the issuer enters into 

the hedge; and (ii) For a three-year period that ends 

on the date the issuer enters into the 

hedge, the average difference between 

the issuer’s actual tax-exempt interest 

rate on comparable variable-rate bonds 

(or, if no such comparable bonds exist, 

rates from a reasonable tax-exempt 

interest rate index, such as the SIFMA 

Municipal Swap Index, for that same 

period) and interest rates determined in 

the same manner as the floating interest 

rate on the hedge and as of the same 

dates as the issuer’s comparable 

variable-rate bonds (or the tax-exempt 

market index, if applicable) does not 

exceed one-quarter of one percent (.25 

percent, or 25 basis points). For 

example, if the floating rate on the 

hedge is 67 percent of LIBOR, then 67 

percent of LIBOR, determined as of the 

same dates as the issuer’s actual interest 

rates (or tax-exempt market index, if 

applicable) is compared to those actual 

interest rates (or the tax-exempt market 

index, if applicable) for the three-year 

period ending on the date the hedge is 

entered into and the differences are 

averaged to determine whether the 

average difference exceeds one-quarter 

of one percent. For this purpose, a 

reasonable sample may be used if the 

sample for the issuer’s actual rates (or 

tax-exempt market index rates, if 

applicable) and the sample of floating 

rates used for the hedge are determined 

as of the same dates. 

(2) A difference resulting from the 

payment of a fixed premium for a cap 

(for example, payments for a cap that 


rmajette on PROD1PC64 with PROPOSALS
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are made in other than level 

installments). 

(3) A difference resulting from the 

allocation of a termination payment if 

the termination was unexpected as of 

the date that the parties entered into the 

hedge contract. 

(vi) * * * For this purpose, such 

payments will be treated as 

corresponding closely in time under this 

paragraph (h)(2)(vi) if they are made 

within 60 calendar days of each other. 

* * * * * 

(viii) Reasonably contemporaneous 

identification. The contract must be 

identified by the actual issuer on its 

books and records maintained for the 

hedged bonds not later than 15 calendar 

days after the date on which the issuer 

and the hedge provider enter into the 

hedge contract. * * * 

(3) * * * 

(iv) * * * 

(B) * * * The amount of the 

termination payment in a termination or 

deemed termination is equal to the fair 

market value of the qualified hedge on 

the date of the termination. * * * 

* * * * * 

(4) * * * 

(i) * * * 

(C) * * * Except for an anticipatory 

hedge that is terminated or otherwise 

closed substantially contemporaneously 

with the hedged bond in accordance 

with paragraph (h)(5)(ii) or (h)(5)(iii) of 

this section, a hedge based on a taxable 

interest rate or taxable interest index 

(for example, the London Interbank 

Offered Rate or LIBOR) does not meet 

the requirements of this paragraph (C). 

* * * * * 

Par. 7. Section 1.148–5(c) is amended 

by: 

1. Removing existing paragraph 

(c)(3)(ii). 

2. Adding introductory language to 

paragraph (c)(3). 

3. Removing the heading in paragraph 

(c)(3)(i) and redesignating the existing 

text in paragraph (c)(3)(i)(A) as the text 

in paragraph (c)(3)(i). 

4. Redesignate existing paragraphs 

(c)(3)(i)(B), (c)(3)(i)(C), (c)(3)(i)(D), 

(c)(3)(i)(E), (c)(3)(i)(F), and (c)(3)(i)(G) as 

paragraphs (c)(3)(ii), (c)(3)(iii), (c)(3)(iv), 

(c)(3)(v), (c)(3)(vi), and (c)(3)(vii), 

respectively. 

5. Redesignate existing paragraphs 

(c)(3)(i)(C)(1) and (c)(3)(i)(C)(2) as 

paragraphs (c)(3)(iii)(A) and 

(c)(3)(iii)(B), respectively, in newly 

redesignated paragraph (c)(3)(iii). 

6. Redesignate existing paragraphs 

(c)(3)(i)(E)(1) and (c)(3)(i)(E)(2) as 

paragraphs (c)(3)(v)(A) and (c)(3)(v)(B), 

respectively, in newly redesignated 

paragraph (c)(3)(v). 

7. Amend newly redesignated 

paragraph (c)(3)(i), (c)(3)(ii), (c)(3)(iii), 

(c)(3)(iv), (c)(3)(v), (c)(3)(vi) and 

(c)(3)(vii) by adding headings to each 

paragraph. 

8. Revise newly redesignated 

paragraph (c)(3)(v). 

9. Revise newly redesignated 

paragraph (c)(3)(vi). 

10. Amend newly redesignated 

paragraph (c)(3)(vii) by removing the 

period at the end of the paragraph and 

replacing it with a semicolon. 

11. Amending paragraph (c)(3) by 

adding new paragraphs (c)(3)(viii) and 

(c)(3)(ix). 

The revised and added provisions 

read as follows: 

§ 1.148–5 Yield and valuation of 

investments. 

* * * * * 

(c) * * * 

(3) Applicability of special yield 

reduction rule. Except as otherwise 

expressly provided in paragraphs 

(c)(3)(i) through (ix) of this section, 

paragraph (c) applies only to 

investments listed in paragraphs (c)(3)(i) 

through (c)(3)(ix) of this section that are 

allocated to proceeds of an issue other 

than gross proceeds of an advance 

refunding issue. 

(i) Nonpurpose investments allocated 

to proceeds of an issue that qualified for 

certain temporary periods. * * * 

(ii) Investments allocable to certain 

variable yield issues. * * * 

(iii) Nonpurpose investments 

allocable to certain transferred 

proceeds. * * * 

(A) * * * 

(B) * * * 

(iv) Purpose investments allocable to 

certain qualified student loans. * * * 

(v) Nonpurpose investments allocable 

to gross proceeds in certain reserve 

funds. Nonpurpose investments 

allocable to gross proceeds of an issue 

in a reasonably required reserve or 

replacement fund or a fund that, except 

for its failure to satisfy the size 

limitation in § 1.148–2(f)(2)(ii), would 

qualify as a reasonably required reserve 

or replacement fund, but only to the 

extent the requirements in paragraphs 

(c)(3)(v)(A) or (B) of this section are met. 

This paragraph (c)(3)(v) includes 

nonpurpose investments described in 

this paragraph that are allocable to 

transferred proceeds of an advance 

refunding issue, but only to the extent 

necessary to satisfy yield restriction 

under section 148(a) on those proceeds 

treating all investments allocable to 

those proceeds as a separate class. 

(A) * * * 

(B) * * * 

(vi) Nonpurpose investments 

allocable to certain replacement 

proceeds of refunded issues. 

Nonpurpose investments allocated to 

replacement proceeds of a refunded 

issue, including a refunded issue that is 

an advance refunding issue, as a result 

of the application of the universal cap 

to amounts in a refunding escrow; 

(vii) Investments allocable to 

replacement proceeds under a certain 

transition rule. * * * 

(viii) Nonpurpose investments 

allocable to proceeds when SLGS are 

unavailable. Nonpurpose investments 

allocable to proceeds of an issue, 

including an advance refunding issue, 

that an issuer purchases on a date when 

the issuer is unable to purchase State 

and Local Government Series Securities 

(SLGS) because the U.S. Department of 

Treasury, Bureau of Public Debt, has 

suspended sales of those securities; and 

(ix) Nonpurpose investments 

allocable to proceeds of certain variableyield advance refunding issues. 

Nonpurpose investments allocable to 

proceeds of a variable-yield advance 

refunding issue (the hedged bond issue) 

deposited in a yield restricted 

defeasance escrow if—

(A) The issuer has entered into a 

qualified hedge under § 1.148–4(h)(2) 

with respect to all of the variable-yield 

bonds of the issue allocable to the yield 

restricted defeasance escrow and that 

hedge is in the form of a variable-tofixed interest rate swap under which the 

issuer pays the hedge provider a fixed 

interest rate and receives from the hedge 

provider a floating interest rate; 

(B) Such qualified hedge covers a 

period beginning on the issue date of 

the hedged bond issue and ending on or 

after the date on which the final 

payment is to be made from the yield 

restricted defeasance escrow; and 

(C) The issuer restricts the yield on 

the yield restricted defeasance escrow to 

a yield that is not greater than the yield 

on the hedged bond issue, determined 

by taking into account the issuer’s fixed 

payments to be made under the hedge 

and by assuming that the issuer’s 

variable yield payments to be paid on 

the hedged bonds are equal to the 

floating payments to be received by the 

issuer under the qualified hedge and are 

paid on the same dates (that is, such 

yield reduction payments can only be 

made to address basis risk differences 

between the variable yield payments on 

the hedged bonds and the floating 

payments received on the hedge). 

* * * * * 

Par. 8. Section 1.148–5(d)(6) is 

amended by revising paragraphs 

(d)(6)(iii)(A)(1) and (d)(6)(iii)(A)(6) to 

read as follows: 


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54614 Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 / Proposed Rules 

§ 1.148–5 Yield and valuation of 

investments. 

* * * * * 

(d) * * * 

(6) * * * 

(iii) * * * 

(A) * * * 

(1) The bid specifications are in 

writing and are timely forwarded, or are 

made available on an internet website or 

other similar electronic media that is 

regularly used to post bid specifications, 

to potential bidders. For purposes of 

this paragraph (d)(6)(iii)(A), a writing 

includes a hard copy, a fax, or an 

electronic e-mail copy. 

* * * * * 

(6) All potential providers have an 

equal opportunity to bid. If the bidding 

process affords any opportunity for a 

potential provider to review other bids 

before providing a bid, then providers 

have an equal opportunity to bid only 

if all potential providers have an equal 

opportunity to review other bids. Thus, 

no potential provider may be given an 

opportunity to review other bids that is 

not equally given to all potential 

providers (that is, no exclusive ‘‘last 

look’’). 

* * * * * 

Par. 9. Section 1.148–5(e)(2) is 

amended by revising the second 

sentence of paragraph (e)(2)(ii)(B) to 

read as follows: 

§ 1.148–5 Yield and valuation of 

investments. 

* * * * * 

(e) * * * 

(2) * * * 

(ii) * * * 

(B) External commingled funds. * * * 

For purposes of this paragraph 

(e)(2)(ii)(B), a fund is treated as widely 

held only if, during the immediately 

preceding fixed, semiannual period 

chosen by the fund (for example, 

semiannual periods ending June 30 and 

December 31), the fund had a daily 

average of more than 15 investors that 

were not related parties, and at least 16 

of the unrelated investors each 

maintained a daily average amount 

invested in the fund that was not less 

than the lesser of $500,000 and one 

percent (1%) of the daily average of the 

total amount invested in the fund (with 

it being understood that additional 

smaller investors will not disqualify the 

fund). * * * 

* * * * * 

Par. 10. Section 1.148–8(d) is revised 

to read as follows: 

§ 1.148–8 Small Issuer Exception to 

Rebate Requirement. 

* * * * * 

(d) Pooled financings—treatment of 

conduit borrowers. A loan to a conduit 

borrower in a pooled financing qualifies 

for the small issuer exception, 

regardless of the size of either the 

pooled financing or of any loan to other 

conduit borrowers, only if—

(1) The bonds of the pooled financing 

are not private activity bonds; 

(2) None of the loans to conduit 

borrowers are private activity bonds; 

and 

(3) The loan to the conduit borrower 

meets all the requirements of the small 

issue exception. 

* * * * * 

Par. 11. Section 1.148–11 is revised 

by adding new paragraph (k) as follows: 

§ 1.148–11 Effective Dates. 

* * * * * 

(k) Certain arbitrage guidance 

updates. 

(1) In general. Sections 1.148–

3(d)(1)(iv); 1.148–3(d)(4); 1.148–4(a); 

1.148–4(b)(3)(i); 1.148–4(h)(2)(ii)(A); 

1.148–4(h)(2)(v); 1.148–4(h)(2)(vi); 

1.148–4(h)(2)(viii); 1.148–4(h)(3)(iv)(B); 

1.148–4(h)(4)(i)(C); 1.148–5(c)(3); 1.148–

5(d)(6)(iii)(A) and 1.148–5(e)(2)(ii)(B), as 

in effect on the effective date of the final 

regulations (the revised provisions), 

apply to bonds sold on or after the date 

that is 90 days after publication of the 

final regulations in the Federal Register, 

for bonds subject to such applicable 

section of the regulations as in effect 

before the effective date of the final 

regulations. 

(2) Permissive earlier application. To 

the extent provided in paragraphs 

(k)(2)(i) through (vi) of this section, 

issuers may apply the proposed 

regulations to bonds sold before the date 

that is 90 days after publication of the 

final regulations in the Federal Register. 

(i) Section 1.148–3(d)(1)(iv) and 

§ 1.148–3(d)(4) may be applied for bond 

years ending on or after the date of 

publication of the proposed regulations 

in the Federal Register for bonds to 

which 1.148–3(d)(1)(iv) applies. 

(ii) Section 1.148–4(b)(3)(i) may be 

applied for bonds sold on or after the 

date of publication of the proposed 

regulations in the Federal Register for 

bonds to which that section applies. 

(iii) Sections 1.148–4(h)(2)(ii)(A), 

1.148–4(h)(2)(v), 1.148–4(h)(2)(vi), 

1.148–4(h)(2)(viii), 1.148–4(h)(3)(iv)(B), 

and 1.148–4(h)(4)(i)(C) may be applied, 

in whole but not in part, for qualified 

hedges entered into on or after the date 

of publication of the proposed 

regulations in the Federal Register for 

bonds to which § 1.148–4(h) applies. 

(iv) Section 1.148–5(c)(3) may be 

applied for investments purchased on or 

after the date of publication of the 

proposed regulations in the Federal 

Register for bonds to which that section 

applies. 

(v) Section 1.148–5(d)(6)(iii)(A) may 

be applied to guaranteed investment 

contracts entered into on or after the 

date of publication of the proposed 

regulations in the Federal Register for 

bonds to which § 1.148–5(d)(6)(iii) 

applies. 

(vi) Section 1.148–5(e)(2)(ii)(B) may 

be applied with respect to investors 

investing in the fund on or after the date 

of publication of the proposed 

regulations in the Federal Register for 

bonds to which that section applies. 

(3) Rebate overpayment recovery. 

Section 1.148–3(j) applies to bonds 

subject to § 1.148–3(i). 

(4) Small issuer exception to rebate 

requirement for conduit borrowers of 

pooled financings. Section 1.148–8(d) 

applies to bonds issued after May 17, 

2006. 

Linda E. Stiff, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 07–4734 Filed 9–24–07; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–148393–06] 

RIN 1545–BG12 

Medical and Accident Insurance 

Benefits Under Qualified Plans; 

Correction 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Correction to notice of proposed 

rulemaking. 

SUMMARY: This document contains 

corrections to notice of proposed 

rulemaking that was published in the 

Federal Register on Monday, August 20, 

2007 (72 FR 46421), regarding the tax 

treatment of payments by qualified 

plans for medical or accident insurance. 

FOR FURTHER INFORMATION CONTACT: 

Pamela Kinard at (202) 622–6060. 

SUPPLEMENTARY INFORMATION: 

Background 

The notice of proposed rulemaking 

(REG–148393–06) that is the subject of 

these corrections is under section 402(a) 

of the Internal Revenue Code. 

Need for Correction 

As published, the notice of proposed 

rulemaking (REG–148393–06) contains 


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